Letter 24: Risk and Reward, Atna Analysis, More Community Banks

Last week I wrote that I did not understand why  the market was reacting as favourably as it was to the European proposals that came out of the Dec 9th summit.

A tweak here, a tweak there and pretty soon you have… well not a whole lot to be honest.

In a way I felt vindicated  by the market collapse that occurred in the early part of this week.  In another way I felt sick to my stomach, because though I have been creating an evermore conservative weighting to my portfolio, when the shit hits you still feel it.

Kyle Bass was on CNBC this week giving some more detail on his doomsday-like expectations:

The observation that deposits are leaving Greek banks at an annualized rate of almost 50% is somewhat frightening.  Clearly this crisis is going to come to a head soon.

John Mauldin publishes a great conversation between Charles Gave and Anatole Kaletsky.   It is quite provoking, and its hard to walk away after reading it without feeling the impending doom that awaits the Eurozone.  Kaletsky and Gave both make the quite reasonable point that perhaps Germany would prefer a break-up of the Eurozone.  If you watch what Germany is doing, and ignore the platitudes they are saying, you might question their motives.  Kaletsky points out that of the necessary measures to fix the Eurozone, Germany seems to be steadfastly opposed to both Eurobonds and to ECB intervention.  Absent those  measures, what hope does the Eurozone have?  Perhaps that is the plan all along.

Gold Stocks – I should went all out

Gold stocks got CREAMED this week.  I had been lightening up on my gold stocks the week before in anticipation that something might be about to hit.  I didn’t like the way gold was going, I didn’t like the fact that the WSJ was penning articles describing a dearth of Indian demand, and I didn’t like that Draghi talked tough during the EU summit, suggesting that money printing was still some time off.

Nevertheless being that I was not fully out of gold stocks, I got smacked about pretty good over the course of the week.   Atna, Aurizon, and with Lydian all performed quite miserably.

What’s Wrong with Aurizon?

Aurizon is a surprise to me.  I expected the stock to hold up better than it has been.  I might have expected its performance to be closer to that of Alamos.  Both are low cost producers.  Both are single mine operations.  Yet the valuation difference between the two is somewhat staggering.

I can only guess that there is a strong seller of Aurizon out there that wants to be out of the stock by year end.  I can only hope that the new year will bring some sanity to the stock.

While reviewing Aurizon, I began to wonder how much having a AMEX listing hurts the stock.  Anecdotally it appeared to me  that the Canadian stocks with AMEX listings are much more volatile then those without.  I decided to take a closer look.

I grabbed price data since August 1st for 9 stocks, 5 with AMEX listings and 4 without.  From the web I grabbed a visual basic function that calculates volatility based on the following Black-Scholes formula.

For purposes of Black-Scholes calculations, volatility is the standard deviation of the periodic percent change in prices, divided by the square root of time.  Volatility is emphatically NOT the same as “beta”, which measures the correlation of a security’s price movements with those of the overall market.  Neither is volatility simply a measure of the standard deviation of a security’s closing prices over time.

Here is the volatility of each security:

Is there a correlation?  Perhaps, though its not as clear a one as I had suspected.   The distinction is most clear between Aurizon, Alamos and Argonaut Gold.  There is no reason, in my opinion, that Aurizon is so much volatile than these other two stocks.  But apart from that, volatility seems similar between stocks on the two indexes.

I bought back some of the shares of Aurizon at $5.07 that I had sold at over $6 a few weeks ago.

The NPV of Atna

Another stock to get clobbered this week was Atna Resources.  I mentioned a couple weeks ago that I had finished an analyses of the company and would post shortly.  I never did that post, until now.

Below is the after tax NPV10 that I calculated for Atna at various gold prices.

I based my model on the following assumptions:

Briggs:

• A 11year mine life, at 40,000 t/d
• Total produced ounces of 476,000 oz over LOM
• 0.017 oz/t resource over the mine life, strip ratio of 4 and with 80% recoveries
• Resulting in gold production of  39,700 oz per year
• Mining costs of $1.30/t mined, milling costs of $4/t milled and G&A costs of $1.7/t mined
• Cash costs of $898/oz over LOM

Pinson:

• A 15 year mine life, beginning at 350t/d and ramping to 750t/d by year 4.
• Total produced ounces of 940,000 oz over LOM
• 0.4 oz/t resource over the mine life, diluted by 30% with 90% recoveries, resulting in gold production beginning at 50,000 oz and ramping to 75,000 oz.
• Mining costs of $110/t, milling costs of $50/t and G&A costs of $11/t
• Cash costs of $687/oz over LOM

Reward:

• A 8 year mine life, at 24,000 t/d
• Total produced ounces of 292,000 oz over LOM
• 0.026 oz/t resource over the mine life, strip ratio of 4 and with 80% recoveries
• Resulting in gold production of  36,400 oz per year
• Mining costs of $1.30/t mined, milling costs of $4/t milled and G&A costs of $1.14/t mined
• Cash costs of $560/oz over LOM

Columbia and Cecil:

• To the current resource of each I assigned a simple asset value per ounce of $40/oz measured and indicated and $20/oz inferred on the total resource of both properties

Atna is, in my opinion, is one of the best gold stock investments out there.  As demonstrated above, the stock is trading at about 1/3 of its NPV 10 at $1500 gold.  If I wanted to get more aggressive in my evaluation, I would note that many companies are moving to value feasibility on NPV5.  On an NPV 5 basis Atna is worth $3.86 per share at $1500/oz gold.  That number jumps to almost $8 per share at $2100/oz gold.  Clearly there is upside once the momentum begins to build.

I added to my position in Atna on Friday at 78 cents.

Taking Advantage of the Collapse

In addition to Atna and Aurizon, I also added new positions in a few juniors.  Call it the beginnings of a basket; I added a couple of non-producing juniors with deposits to my portfolio this week:

Geologix was recommended by Rick Rule as a takeover candidate on BNN about a year ago.  Since that time the stock has fallen significantly.  The company has a very low grade copper-gold deposit called Tepal in Mexico.  The PEA that was published on Tepal a few months ago put the NPV5 of the project at $412M based on $1000/oz gold and 2.75/lb copper.  Geologix has $14M of cash on hand.  With 145M shares outstanding, the market capitalization of the company was $28M at my entry price of 20 cents.  That puts half the market cap in cash and the other half in a project with an NPV that is nearly 10x the value of the company.  Something has to give here.

Esperanza Resources is another old Rick Rule recommendation.  Rule doesn’t talk much about specific stocks anymore, but there is some evidence that he is still interested in the company.  http://www.investmentu.com/2011/September/why-gold-mining-stocks-will-skyrocket.html .  The company certainly fits the bill of the sort of stock Rule likes.  Esperanza has 1Moz of gold in Mexico.   It’s a heap leach project so it should be able to be brought on production without a massive capital requirement (about $100M).  Like Geologix, the company has almost half its market cap ($100M) in cash on hand ($50M).

I plan to add more to both of these stocks in the coming weeks.

Regional Banks: A  Position in Community Bankers Trust

Community Bankers Trust (BTC) hit my bid when it sold off back down to a dollar this week.  BTC is trading at 27% of tangible book value.  This is, of course, partially because of the large number of non-performing loans on their books.  Non-performing loans make up 8.9% of total loans in the Q3 quarter.  This was down from 10.1% in Q2.  In fact, there are some encouraging signs that the worst of the loan losses are behind us.  The company has shown 3 quarters of lower loan amounts 30-89 days past due.  This trend is beginning to show up in the total non-performing loans, which decreased for the first time in a year in Q3.

Moreover, as I have pointed out previously, insiders continue to buy the stock.  Third quarter purchases by insiders were a little less than $50,000.

And Another Regional Bank Position in Atlantic Coast Financial

To be perfectly honest, I might have made a mistake here.  I’ve only put a very tiny amount of capital at risk, but even that may have been too much.   Atlantic Coast Financial (ACFC) is a lottery ticket.  I bought the stock at $1.70 on Friday.  There is just as much chance that it will go to zero as there is that it will double.

ACFC is a former Mutual Holding company that did their second step bank in February.  The second step added cash to the balance sheet and resulted in a bank trading well below book value.  ACFC trades at a rather crazy 10% of tangible book.  Clearly there is more to the story.

The more to the story is that the bank is centered in Jacksonville Florida.  They primarily make residential real estate loans.  Real estate in Jacksonville has not done particularly well over the last few years (though it appears to be bottoming).

The falling real estate prices have led to skyrocketing non-performing loans.  Those non-performing loans have not shown any sign of peaking yet (thus the possible mistake on my part).

The questions are, how many of these nonperforming loans will eventually be written down, and will there be value left in the equity once the non-performing loans are written down.

What drove me to take a small position in the stock was in part that an improving economy, and stabilizing home prices in Jacksonville, may mitigate further deterioration of the bank assets.  As well, the bank is generating decent earnings before provisions.  Ignoring provisions in Q3, the bank earned $1.16 per share.  In Q2 that number was $0.55.

What is going on at ACFC is something akin to a tug-of-war, whereby on the one hand loan losses strip away value every quarter, while on the other earnings power of the performing loans adds value back.  The share price is so low that it doesn’t take much a a shift in the dynamic between these two forces to change the value equation substantially.  Its easy to see how a stabilization in non-performing loans could quickly allow the earnings power to win the race and shareholder value to go up substantially.

The other factor in my decision to buy was the recent announcement that the company was looking into strategic alternatives.

On November 28, 2011, Atlantic Coast Financial Corporation issued a press release announcing that its Board of Directors has engaged Stifel, Nicolaus & Company, Incorporated to assist the Company in exploring strategic alternatives to enhance stockholder value

Part of the reason that the company is looking for options is that they are not in compliacne with the Individual Minimum Capital Requirement (IMCR) agreed to by the Bank with the Office of Thrift Supervision on May 13, 2011.  Under the IMCR, ACFC agreed to achieve Tier 1 leverage ratio of 7.0% as of September 30, 2011. Tier I capital at the bank is 6.22% right now.

It is a far from perfect scene.  Nevertheless, an improving US economy and stabilizing housing prices could give me a decent return on the stock.  The book value of $19 is unrealistic, a return to $3 is not.

Portfolio Composition